Reference no: EM132184434
International Financial Management Problem 
You are trying to decide how to hedge euro 5,000,000 accounts receivable due in one year. Current interest rates and exchange rates are:
Spot rate: $1.25/euro
1year forward rate: $1.19/euro
1year interest rates
€ interest rate: 2.20% per annum
$ interest rate: 2.00% per annum
Call option: $1.20 strike, premium $0.025/€
Put option: $1.20 strike, premium S0.0125/€
Note: Please answer the short questions in addition to completing the table
a. If you are unhedged, what is your A/R payment in USD given different future spot rates? Complete the table below. In general, what is the accounts receivable in dollars if unhedged.
Future Spot Rate

A/R proceeds in USD

1.10


1.15


1.20


1.25


1.30


b. How to hedge in the forward market? If you use forward to hedge, what is your A/R payment in USD given different future spot rates? Complete the table below. In general, what is the value of the receivable in one year if you use a forward hedge?
Future Spot Rate

A/R proceeds in USD

1.10


1.15


1.20


1.25


1.30


c. How to hedge in the option market? If you use option to hedge, what is your A/R proceeds in USD given different future spot rates? Complete the table below. What is the minimum net proceeds in USD?
Future Spot Rate

Exercise or not

USD gross proceeds for 5 million euro (exclude premium)

Premium (FV)

USD net proceeds

1.10





1.15





1.20





1.25





1.30





d. How to hedge in the money market? Calculate the value of the receivable if it uses a money market hedge?
Future Spot Rate

A/R proceeds in USD

1.10


1.15


1.20


1.25


1.30


e. Draw the graph for all four strategies.
f. Calculate the breakeven exchange rate (against the forward) for the appropriate option contract.
g. If you believe the spot rate in one year will actually be $1.21/euro which strategy would you recommend?
h. If you believe the spot rate in one year will actually be $1.17/euro which strategy would you recommend?